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Building Retirement for Key, Non-Owner Employees

Brought to you by the Nationwide® Advanced Sales Team

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Things you need to know

• This presentation was not intended by the author to be used, and cannot be used, by anybody for the purpose of avoiding any penalties that may be imposed on you pursuant to the Internal Revenue Code. The information contained herein was prepared to support the promotion, marketing and/or sale of life insurance contract, annuity contracts and/or other products and services provided by Nationwide life Insurance Company.

• Federal tax laws are complex and subject to change. Neither the company nor its representatives give legal or tax advice. P lease talk with your attorney or tax advisor for answers to your specific questions.

• As your clients’ personal situations change (i.e., marriage, birth of a child or job promotion), so will their life insurance needs. Care should be taken to ensure these strategies and products are suitable for long-term life insurance needs. You should weigh your clients’ objectives, time horizon and risk tolerance as well as any associated costs before investing. Also, be aware that market volatility can lead to the possibility of the need for additional premium in the policy. Variable life insurance has fees and charges associated with it that include costs of insurance that vary with such characteristics of the insured as gender, health and age, underlying fund charges and expenses, and additional charges for riders that customize a policy to fit your clients’ individual needs.

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Things you need to know

• This information assumes that the life insurance is not a modified endowment contract, or MEC. As long as the contract meets the non-MEC definitions of IRC Section 7702A, most distributions are taxed on a first-in/first-out basis. Surrender charges may apply to partial surrenders. Loans and partial surrenders from a MEC will generally be taxable, and if taken prior to age 59 ½, may be subject to a 10% tax penalty. Loans and partial surrenders will reduce the cash value and the death benefits payable to your beneficiaries, and withdrawals above the available free amount will incur surrender charges. If you contract were to lapse with a loan outstanding, the loan amount in excess of basis will be treated as a distribution and all or a portion will be subject to income tax.

• Investing involves risk, including possible loss of principal.• When evaluating the purchase of a variable annuity, your clients

should be aware that variable annuities are long-term investment vehicles designed for retirement purposes and will fluctuate in value; annuities have limitations; and investing involves market risk, including possible loss of principal.

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Things you need to know

• The underlying investment options to a variable annuity or life insurance product are not publicly traded mutual funds and are not available directly for purchase by the general public. They are only available through variable annuity/variable life insurance policies issued by life insurance companies.

• Life insurance is issued by Nationwide Life Insurance Company or Nationwide Life and Annuity Insurance Company, Columbus, Ohio, member of Nationwide Financial®. The general distributor for variable insurance products is Nationwide Investment Services Corporation, member FINRA.

• © 2011, Nationwide Financial Services, Inc. All rights reserved.

• Not a deposit • Not FDIC or NCUSIF insured • Not guaranteed by the institution

• Not insured by any federal government agency • May lose value

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Agenda

•Qualified plans

•Nonqualified Deferred Compensation

•Insurance Based Retirement Plan

•IBRP for the Business Owner

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Qualified Plans

• The first alternative

• Advantages– Current tax deduction– Tax deferred growth

• Disadvantages– Broad participation– Administrative expenses– Benefits taxable

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Qualified Plan Limitations

• Cost

• Insufficient participation

• Contribution limits

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Nonqualified Deferred Compensation Plans Advantages

• Flexible design

• Discriminatory

• No contribution limits

• Effective golden handcuff

• Pre-tax investing for non owner

• Funded with COLI

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Nonqualified Deferred Compensation Plan Drawbacks

• Unsecured promise to pay

• Creditors’ claims

• In line with general creditors

• No current tax deduction

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NQDC Plan- Candidate

• Stable Business– Profits– Cash flow

• Has Executives/HCEs• Retention more important than

taxes• Willing to take longer view• Effective plan for right employer

& right employees

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NQDC Plan- Difficulties

Employer not a candidate– Business too young– Business too small – Unstable profit & cash flow– Candidates not comfortable

• Unsecured promise to pay

– Expensive documentation and administration

– Employer wants income tax deduction

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Conclusion

For the Key Non-Business Owner Employees Qualified & NQDC Plans may not be the complete solution

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Other Ways to Building for Retirement• Stocks & Bonds

– Dividends & appreciation but current taxation

• Mutual Funds & ETFs– Dividends & appreciation but current taxation

• Annuities– Tax deferred growth but all ordinary income– Income in respect of a decedent

• IRAs– May be tax deductible but ordinary income

• Roth IRAs– Tax free income but contribution limits

Investing involves risk, including possible loss of principal.

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Another Solution

Insurance Based Retirement Plan

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What is an Insurance Based Retirement Plan?

• A combination of:– the death benefit features of life insurance to

protect the client’s family– with the tax preferences of life insurance to

potentially invest and supplement retirement income in a tax efficient manner

• Based on a life insurance policy– Personally owned – owned outside the business– Not a Modified Endowment Contract (non MEC)– Not a life insurance policy – a way to use one

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What is an Insurance Based Retirement Plan?• Designed around cash accumulation life

insurance• Provides supplemental retirement income• Universal life effective vehicle

– Non MEC– Withdrawals to recover cost basis– Borrow thereafter– Income is tax-free as long as policy in force

• Income tax-free death benefit – Repays loans– Balance to personal beneficiaries (estate taxes

may apply if estate and trust planning has not been done)

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Client Profile for Universal Life

• Needs life insurance• Would be interested in

– Flexible death benefit– Lack of contribution limitations

• Can overfund policy but avoid MEC status• Consistent with underwriting offer

– Investing tax-preferred– Tax-deferred accumulation– Tax-preferred access to policy values

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Universal Life Features

• Tax-deferred accumulation of internal values

• Cash value access through withdrawals & loans

• Non-MEC status maintained– No penalty for taking income prior to 59½– Tax free income as long as policy stays in force

• Flexible death benefit• Income tax free death benefit to

beneficiaries– Policy benefit repays loans– Withdrawals & loans reduce net death benefit.

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Maximum Funding

• An IBRP is based on a dual need– Life insurance for the family– Vehicle for tax-preferred investing

• IBRPs work best when maximum funded– Provides more funds for highs and lows of

market– Minimizes mortality costs

• Two ways to plan maximum funding– Choose a death benefit, pay maximum premium– Choose a premium, solve for minimum death

benefit that meets clients needs

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Typical IBRP Scenario

• Policy owned by insured• Maximum non-MEC premium

– 15 – 20 years• In retirement

– Recover cost basis through policy withdrawals

– Switch to loans – Keep policy in force until death

• Overloan rider

• Death benefit repays loans– Balance to beneficiaries.

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Tax Equivalence

• Taxable retirement income• IBRP income tax free• Divide by “after-tax” percentage• $12,000 IBRP payment & 33%

tax bracket• Taxable equivalent = $12,000 ÷

(1 – 33%)• Taxable equivalent = $12,000 ÷

67% = $18,000

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Universal Life Variations

• Cash accumulation/Current assumption

• Indexed

• Variable

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Cash Accumulation/ Current Assumption UL

• Guaranteed minimum crediting rate• Premiums invested

– High grade bonds– Mortgages

• Interest crediting rate adjusted for changes in investment portfolio yield, etc.

• May have features to enhance cash accumulation

• Overloan protection riders**Riders are offered at an additional cost and may not be available in all states. A life insurance or annuity purchase should be based on the life insurance or annuity contract, and not optional riders or features. The cost of an option may exceed the actual benefit paid under the option.

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Indexed Universal Life

• Not a security• Crediting rates adjusted for

increases in stock market indexes• Choose the index• Participation rate• Cap rate• Minimum crediting rate• No risk of loss of principal• Overloan protection riders

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Variable Universal Life Features

• Permits investment in equity-based sub-accounts

• No tax due when switching sub-accounts

• No tax due on dividends, interest, or trading gains

• No tax due on annual cash value growth

• Sub-account reallocations without charge– Subject to limitations in prospectus

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Variable Universal Life Features

• Cash value not subject to creditors of insurance company

• Wash loans

• Overloan protection riders

• Buy term and invest the difference

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Variable Universal Life Suitability

• Willing to invest for the long haul 15 – 20 years

• Wants market opportunity through investment in fixed and variable sub-accounts

• Accepts risk of loss of principal

• Understands market volatility of sub-account investments

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Variable Universal Life Limitations

• Insurable with reasonable health• Market risk• Additional funds may be required

when not properly funded• Income may be higher or lower than

illustrated, depending on market performance

• Loans taken from the policy, when policy lapses before death, will be taxable

• Over loan Protection Rider

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Seven Layers of Tax Insulation

Income from IBRP is free from– Federal Income Tax – State Income Tax– Local Income Tax– Capital Gains Tax– FICA/Social Security Tax– No effect on Alternative Minimum Tax– No effect on percentage of Social

Security benefits subject to income taxation

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Client Profile for IBRP

• Who is a Potential Client for an IBRP?• Age 35-55• High income individuals with cash flow• Comfortable with equity or market

exposure• Believe in long-term investing• Executives who have maximized qualified

plans but wish to invest more• Clients who want tax preferences without

the restrictions of qualified plans• Business owners without access to

qualified plans (plan for self)

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Funding the IBRP for the Key Non-Owner Employees

• Split Dollar– Collateral Assignment/Loan

Regime– Endorsement/Economic Benefit

Regime

• Executive Bonus• Restrictive Executive Bonus

Arrangement (REBA)

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Split Dollar: Collateral Assignment/Loan Regime

• Effective fringe benefit– Low cost life insurance– Golden handcuff

• Employer loans premiums• Employee owns policy/collateral

assignment• Employee taxed on interest free element of

loan• Employee taxation & employer deduction if

loans forgiven• Documentation & significant administration• Covered by 409A if employer promises to

forgive loan

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Split Dollar: Endorsement/Economic Benefit Regime

• Effective fringe benefit– Low cost life insurance– Golden handcuff

• Employer owns policy• Employee names beneficiary• Employee taxed on value of insurance coverage• Employee taxation for FMV if policy transferred• Employer deduction for premiums if policy transferred• Documentation & significant administration• 101(j) & possible 409A

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Executive Bonus

• Effective fringe benefit• Section 162 Plan• A raise in pay• Reasonable compensation• Payroll and income tax

withholding• Employee owns policy• Current tax deduction

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Executive Bonus

• Pro– Very simple– Minimal documentation– Current tax deduction

• Con– Little “retain” incentive– Little golden handcuff

• Loyal employee

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Restrictive Executive Bonus Arrangements

The simple Golden Handcuff– A raise in pay – additional compensation– Payroll and income tax withholding– Employee owns policy– Current tax deduction– Reasonable compensation– Some written documentation

• Repayment obligation

• Restrictive endorsement

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Repayment Obligations

• First element of Golden Handcuff• Repayment obligation

– Employee repays some or all of the additional compensation

– Time bound – expires at a future date– No collateral assignment

• Design flexibility– Employer & Employee can negotiate

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Restrictive Endorsement

• Second element of Golden Handcuff• Employee can change beneficiary• Access to policy values requires

employer’s signature• Time bound

– Expires at a future date– Usually coordinated w/expiration of

repayment obligation

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Flexibility in Designing Repayment Obligation

• 5 year graded or cliff

• 10 year graded or cliff

• Graded to retirement

• Cliff at retirement

• Whatever ER and EE negotiate

• Can be modified

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Tax Considerations

• IRC §162(a)(1) - Compensation

• IRC §264(a)(1) - Indirect beneficiary

• IRC §61 – Income

• IRC §83 - Risk of forfeiture

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If Employee Leaves Before Obligation is Satisfied?

• IRC §1341, Claim of Right Doctrine– Deductible for employee

• IRC §61– Taxable income to employer

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REBA Drawbacks• No policy ownership for employer• No security interest• Lack of control• All covered by written agreements

– Nonqualified deferred compensation– Collateral assignment split dollar– Endorsement Split Dollar– Restrictive Executive Bonus

Arrangement

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Advantages of REBA

• Current income tax deduction

• Significant incentive to stay

• Minimal documentation

• Employee feels more confident

• No 409A issue

• No 101(j) issue

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Conclusion: Funding the IBRP for the Key Non-Owner Employee

• Split dollar– Low cost life insurance– Documentation & administration– No current tax deduction for premiums

• Executive Bonus– Little incentive to stay– Loyal employee

• Restrictive Executive Bonus Arrangement– Tax deductible – Golden handcuff– Employee comfort – employee owns life

insurance

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Questions?

•Independent Dealer: 1-800-321-6064

•Financial Institutions: 1-800-893-5399

•Wirehouse/Regionals:1-800-720-1511

•Nationwide Agents: 1-888-333-4202

•Nationwide Financial Network: 1-877-223-0795

•BGA: 1-888-767-7373